Two essays on financial structure and corporate policy

Essay One: Financial Constraints, Macroeconomic Conditions, and Financing Decisions This paper empirically examines the impact of real economic activity and capital market conditions on firms’ financing choices between 1975 and 2006. Through principal component analysis, we decompose a number of macroeconomic variables into three principal components that capture different aspects of macroeconomic conditions. High (low) values of the first component correspond to a recovering economy with low inflation (stagflation); high (low) values of the second component correspond to an overheating economy (recession); and high (low) values of the third correspond to high (low) stock and bond market returns but are unrelated to real economic activity. Financially constrained and unconstrained firms respond differently to these macroeconomic conditions. Financially unconstrained firms increase debt maturity during recovery when long-term debt appears less risky, and reduce debt maturity towards the crest of the business cycle when the opposite is the case. In contrast, the benefits of improving debt and equity market conditions spread more slowly to the financially constrained firms, and they appear to have less flexibility in financing choices when conditions worsen. However, the financing activities of the financially constrained firms are much more sensitive to capital market conditions that seem unrelated to economic fundamentals. Essay Two: Determinants and Real Impact of Debt Rollover: Evidence from Debt Reclassifications Debt rollover, as an integral aspect of firms’ financing decisions, remains relatively underexplored because it is difficult to be identified empirically. Debt reclassifications, which indicate intent by firms to roll over their short-term debt on a long-term basis, provide us a unique opportunity to study debt rollover. Reclassifications are surprisingly common among S&P 1500 firms. Over the 1993-2005 period, on average, 33% of the firms reclassify short-term debt as long-term debt each year. Among firms that reclassify short-term debt, the average percentage of reclassified debt to total debt is as high as 40%. We empirically examine the factors that determine the decision of firms to roll over existing or new short-term debt via reclassification. We find that younger and smaller firms, as well as firms with intermediate and no S&P credit ratings, are more likely to roll over debt via reclassifications. Firms are also more likely to roll over debt via reclassification when they have major investment projects, market conditions are not favorable for equity and long-term debt issuance, and refinancing risk is high. Firms that reclassify overcome the financing frictions and achieve significantly higher sales and asset growth, and invest more in both fixed assets and working capital. Consistent with the idea that firms face tighter financial constraints around periods of reclassification than expected future constraints, we find that the cash flow-sensitivity of investment increases and that of cash holdings decreases at the time of debt reclassification.